-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, C7yk9w8N4TJdcwX61n0J+qPYGUcqfLcHNSIfgISria69vFpt48vmecHnYJegJXA+ 12LyYtAGP4862LNeHhOm9A== 0000910394-02-000004.txt : 20020414 0000910394-02-000004.hdr.sgml : 20020414 ACCESSION NUMBER: 0000910394-02-000004 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 1 CONFORMED PERIOD OF REPORT: 20011229 FILED AS OF DATE: 20020211 FILER: COMPANY DATA: COMPANY CONFORMED NAME: KENTUCKY ELECTRIC STEEL INC /DE/ CENTRAL INDEX KEY: 0000910394 STANDARD INDUSTRIAL CLASSIFICATION: STEEL WORKS, BLAST FURNACES ROLLING MILLS (COKE OVENS) [3312] IRS NUMBER: 611244541 STATE OF INCORPORATION: DE FISCAL YEAR END: 0930 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 000-22416 FILM NUMBER: 02533421 BUSINESS ADDRESS: STREET 1: P O BOX 3500 CITY: ASHLAND STATE: KY ZIP: 41105-3500 BUSINESS PHONE: 6069291222 MAIL ADDRESS: STREET 1: P O BOX 3500 CITY: ASHLAND STATE: KY ZIP: 41105-3500 10-Q 1 firstq.txt FORM 10-Q SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 (Mark One) X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended December 29, 2001 OR TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from ______________to_____________________. Commission File No. 0-22416 KENTUCKY ELECTRIC STEEL, INC. (Exact name of Registrant as specified in its charter) Delaware 61-1244541 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification Number) P. O. Box 3500, Ashland, Kentucky 41105-3500 (Address of principal executive office, Zip Code) (606) 929-1222 Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES X NO The number of shares outstanding of each of the issuer's classes of common stock, as of February 11, 2002, is as follows: 4,100,285 shares of voting common stock, par value $.01 per share. KENTUCKY ELECTRIC STEEL, INC. AND SUBSIDIARY TABLE OF CONTENTS Page PART I. FINANCIAL INFORMATION Item 1 - Financial Statements Condensed Consolidated Balance Sheets ............. 3 Condensed Consolidated Statements of Operations ... 4 Condensed Consolidated Statements of Cash Flows ... 5 Notes to Condensed Consolidated Financial Statements ..................................... 6-10 Item 2 - Management's Discussion and Analysis of Financial Condition and Results of Operations ............. 11-14 Item 3 - Qualitative and Quantitative Disclosures about Market Risk ..................................... 14 PART II. OTHER INFORMATION Item 6 - Exhibits and Reports on Form 8-K .................. 15 SIGNATURES ....................................... 16 KENTUCKY ELECTRIC STEEL, INC. AND SUBSIDIARY CONDENSED CONSOLIDATED BALANCE SHEETS (Dollars in Thousands) (Unaudited) Dec. 29, Sept. 29, ASSETS 2001 2001 CURRENT ASSETS Cash and cash equivalents $ 2,761 $ 7,505 Accounts receivable, less allowance for doubtful accounts and claims of $635 at December 29, 2001 and $695 at September 29, 2001 6,823 8,600 Inventories 17,725 16,962 Operating supplies and other current assets 5,491 5,128 Total current assets 32,800 38,195 PROPERTY, PLANT AND EQUIPMENT Land and buildings 5,881 5,881 Machinery and equipment 35,252 35,252 Construction in progress 172 162 Less - accumulated depreciation (20,621) (19,936) Net property, plant and equipment 20,684 21,359 OTHER ASSETS 442 460 Total assets $ 53,926 $ 60,014 LIABILITIES AND SHAREHOLDERS' EQUITY CURRENT LIABILITIES Advances on line of credit $ 12,115 $ 12,141 Accounts payable 4,627 6,303 Accrued liabilities 2,537 3,691 Current portion of long-term debt 1,625 125 Total current liabilities 20,904 22,260 LONG-TERM DEBT 15,167 16,667 DEFERRED GAIN FROM SALE-LEASEBACK 675 704 Total liabilities 36,746 39,631 COMMITMENTS AND CONTINGENCIES SHAREHOLDERS' EQUITY Preferred stock, $.01 par value, 1,000,000 shares authorized, no shares issued - - Common stock, $.01 par value, 15,000,000 shares authorized, 5,051,566 shares issued 51 51 Additional paid-in capital 15,817 15,817 Less treasury stock - 951,281 shares at cost (4,309) (4,309) Retained earnings 5,621 8,824 Total shareholders' equity 17,180 20,383 Total liabilities and shareholders' equity $ 53,926 $ 60,014 See notes to condensed consolidated financial statements KENTUCKY ELECTRIC STEEL, INC. AND SUBSIDIARY CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (Dollars in Thousands, Except Per Share Data) (Unaudited) Three Months Ended Dec. 29, Dec. 30, 2001 2000 NET SALES $ 16,029 $ 17,279 COST OF GOODS SOLD 16,945 17,006 Gross profit (loss) (916) 273 SELLING AND ADMINISTRATIVE EXPENSES 1,824 1,857 Operating loss (2,740) (1,584) INTEREST INCOME AND OTHER 58 137 INTEREST EXPENSE (521) (516) Loss before income taxes (3,203) (1,963) CREDIT FOR INCOME TAXES - (739) Net loss $ (3,203) $ (1,224) NET LOSS PER COMMON SHARE - BASIC AND DILUTED $ (.78) $ (.30) WEIGHTED AVERAGE SHARES OUTSTANDING - BASIC 4,100,285 4,072,476 WEIGHTED AVERAGE SHARES OUTSTANDING - DILUTED 4,100,285 4,072,476 See notes to condensed consolidated financial statements KENTUCKY ELECTRIC STEEL, INC. AND SUBSIDIARY CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Dollars in Thousands) (Unaudited) Three Months Ended Dec. 29, Dec. 30, 2001 2000 Cash Flows From Operating Activities: Net loss $ (3,203) $ (1,224) Adjustments to reconcile net loss to net cash flows from operating activities: Depreciation and amortization 661 671 Change in deferred taxes - (824) Change in other assets 13 13 Change in current assets and current liabilities: Accounts receivable 1,777 3,179 Inventories (763) 366 Operating supplies and other current assets (363) (670) Deferred tax assets - 84 Accounts payable (1,676) (3,268) Accrued liabilities (1,154) (1,311) Net cash flows from operating activities (4,708) (2,984) Cash Flows Used By Investing Activities: Capital expenditures (10) (185) Net cash flows from investing activities (10) (185) Cash Flows Used By Financing Activities: Net advances on line of credit (26) 1,972 Repayments on long-term debt - (3,334) Issuance of common stock - 3 Net cash flows from financing activities (26) (1,359) Net decrease in cash and cash equivalents (4,744) (4,528) Cash and Cash Equivalents at Beginning of period 7,505 8,688 Cash and Cash Equivalents at End of Period $ 2,761 $ 4,160 Interest Paid $ 792 $ 920 Income Taxes Paid $ - $ - See notes to condensed consolidated financial statements KENTUCKY ELECTRIC STEEL, INC. AND SUBSIDIARY NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (1) Basis of Presentation The accompanying unaudited condensed consolidated financial statements include the accounts of Kentucky Electric Steel, Inc. and its wholly-owned subsidiary, KESI Finance Company, which was formed in October 1996 to finance the ladle metallurgy facility. On September 28, 2001, the Company dissolved KESI Finance Company as a separate legal entity. As such, the financial statements for the quarter ending December 30, 2000 reflects the activity for KESI Finance Company. All significant intercompany accounts and transactions have been eliminated. These statements have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation have been included. Operating results for the three month period ended December 29, 2001 are not necessarily indicative of the results that may be expected for the year ending September 28, 2002. For further information, refer to the financial statements and footnotes thereto included in the Company's annual report on Form 10-K for the year ended September 29, 2001. (2) Nature of Operations Nature of Operations Kentucky Electric Steel, Inc. (KESI or the Company), a Delaware corporation, owns and operates a steel mini-mill near Ashland, Kentucky. The Company manufactures special bar quality alloy and carbon steel bar flats to precise customer specifications for sale in a variety of niche markets. During the past three years, market conditions within the domestic steel industry have experienced significant downward economic pressure largely due to market price and shipment volume declines. These market conditions are a result of a number of factors including a decline in the general economy of the United States, a decline in the industries of the Company's customers, the increased cost of production due to high electricity and natural gas costs and an increase in competition from foreign steel companies. These forces have driven market prices to levels below the cost of production for certain domestic producers, and as a result, many steel manufacturers have curtailed production or ceased operations, and a number of steel industry producers have sought protection under the United States Bankruptcy Code. (3) Accounting Principles Accounting Estimates The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates. Reclassifications Certain reclassifications of previously reported amounts have been made to conform with current classifications. Cash and Cash Equivalents Cash includes currency on-hand and deposits with financial institutions. Cash equivalents consist of investments with original maturities of three months or less. Amounts are stated at cost, which approximates market value. Inventories Inventory costs include material, labor and manufacturing overhead. Inventories are valued at the lower of average cost or market. Property, Plant and Equipment and Depreciation Property, plant and equipment is recorded at cost, less accumulated depreciation. For financial reporting purposes, depreciation is provided on the straight-line method over the estimated useful lives of the assets, generally 3 to 12 years for machinery and equipment and 15 to 30 years for buildings and improvements. Depreciation for income tax purposes is computed using accelerated methods. Expenditures for maintenance and repairs are charged to expense as incurred. Expenditures for equipment renewals, which extend the useful life of any asset, are capitalized. The Company assesses its long-lived assets for impairment when events and circumstances indicate the assets may be impaired and the undiscounted cash flows estimated to be generated by those assets are less than their carrying amounts. Revenue Recognition The Company recognizes revenue from sales at the time of shipment. Income Taxes The Company accounts for income taxes pursuant to the asset and liability method. Deferred tax assets and liabilities are recognized based upon the estimated increase or decrease in taxes payable or refundable in future years expected to result from reversal of temporary differences and utilization of carryforwards which exist at the end of the current year. Temporary differences represent the differences between the financial statement carrying amount of assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates scheduled to apply to taxable income in the years in which the temporary differences are expected to be settled, and are adjusted in the period of enactment for the effect of a change in tax law or rates. Valuation allowances are provided against deferred tax assets for which it is "more likely than not" the assets will not be realized. The realization of deferred tax assets is dependent in part upon generation of sufficient future taxable income. Management has considered the levels of currently anticipated pre-tax income in assessing the required level of the deferred tax asset valuation allowance. After taking into consideration historical pre-tax income levels, the results of operations from fiscal 1999, 2000 and 2001, the potential limitation of net operating losses under Section 382 of the Internal Revenue Code and other available objective evidence, the realization of the deferred tax asset is no longer more likely than not. Therefore, the Company's valuation allowance fully reserves for the net deferred tax asset. Also, realization of deferred tax assets may be limited by Section 382 of the Internal Revenue Code. Section 382 of the Internal Revenue Code contains rules designed to discourage persons from buying and selling the net operating losses of companies. These rules generally operate by focusing on ownership changes among stockholders owning directly or indirectly 5% or more of the common stock of a company or any change in ownership arising from a new issuance of stock by a company. In general, Section 382 rules limit the ability of a company to utilize net operating losses after a change of ownership of more than 50% of its common stock over a three-year period. Purchases of our common stock in amounts greater than specified levels could inadvertently create a limitation on our ability to utilize our net operating losses for tax purposes in the future. Fiscal Year End The Company's fiscal year ends on the last Saturday of September. Segment Information Operating segments are defined as components of an enterprise about which separate financial information is available that is evaluated regularly by the decision-making group in deciding how to allocate resources. The Company has one business unit. New Accounting Pronouncements SFAS No. 142 "Goodwill and Other Intangible Assets" In July 2001, the Financial Accounting Standards Board issued Statement No. 142 (SFAS 142) "Goodwill and Other Intangible Assets". SFAS 142 establishes accounting and reporting standards for acquired goodwill and other intangible assets. It requires that an entity cease amortization of goodwill and certain intangible assets and establishes an annual requirement to test these assets for impairment. This standard is required to be adopted for fiscal years beginning after December 15, 2001. As such, the Company is not required to adopt this standard until the fiscal year beginning September 29, 2002. Early application of this standard is permitted for entities with fiscal years beginning after March 15, 2001. The Company did not early adopt this standard. Management does not believe that the adoption of this standard will have a material impact on the financial position or results of operations of the Company. SFAS No. 143 "Accounting for Asset Retirement Obligations" In August 2001, the Financial Accounting Standards Board issued Statement No. 143 (SFAS 143) "Accounting for Asset Retirement Obligations". SFAS 143 addresses financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. This standard is required to be adopted for fiscal years beginning after June 15, 2002. As such, the Company is not required to adopt this standard until the fiscal year beginning September 29, 2002. Management does not believe that the adoption of this standard will have a material impact on the financial position or results of operations of the Company. SFAS No. 144 "Accounting for the Impairment or Disposal of Long- Lived Assets In October 2001, the Financial Accounting Standards Board issued Statement No. 144 (SFAS 144) "Accounting for the Impairment or Disposal of Long-Lived Assets". SFAS 144 addresses financial accounting impairment or disposal of long-lived assets and requires that one accounting model be used for long-lived assets to be disposed of by sale and broadens the presentation of discontinued operations to include more disposal transactions. This standard is required to be adopted for fiscal years beginning after December 15, 2001. As such, the Company is not required to adopt this standard until the fiscal year beginning September 29, 2002. Management does not believe that the adoption of this standard will have a material impact on the financial position or results of operations of the Company. (4) Inventories Inventories at December 29, 2001 and September 29, 2001 consist of the following ($000's): Dec. 29, Sept. 29, 2001 2001 Raw materials $ 1,686 $ 2,113 Semi-finished and finished goods 16,039 14,849 Total inventories $ 17,725 $ 16,962 (5) Earnings Per Share The following is the reconciliation of the numerators and denominators of the basic and diluted earnings per share computations. For the Three For the Three Months Ended Months Ended December 29, 2001 December 30, 2001 Per Per Net Share Net Share (Loss) Shares Amount (Loss) Shares Amount Amounts for Basic Earnings Per Share $(3,203) 4,100,285 $(.78) $(1,224) 4,072,476 $(.30) Effective of Dilutive Securities Options - - - - - - Amounts for Diluted Earnings Per Share $(3,203) 4,100,285 $(.78) $(1,224) 4,072,476 $(.30)
The following options were not included in the computation of diluted loss per share because to do so would have been antidilutive for the applicable period: Dec. 29, 2001 Dec. 30, 2000 Transition stock options 26,633 49,590 Employee stock options 601,744 561,052 628,377 610,642 (6) Advances on Line of Credit and Long-Term Debt Long-term debt of the Company at December 29, 2001 and September 29, 2001, as restructured, consists of the following ($000's): Dec. 29, Sept. 29, 2001 2001 Secured senior notes, due in annual installments from November 2002 through 2005, interest at 9.00% $ 16,667 $ 16,667 Other 125 125 16,792 16,792 Less - Current portion (1,625) (125) $ 15,167 $ 16,667 At December 29, 2001, before the debt restructuring, the Company had outstanding borrowings of $16.7 million on the unsecured senior notes. These notes bore interest at a fixed rate of 7.66% per annum, with interest paid semi-annually. Additionally, the Company had a $24.5 million unsecured bank credit facility which expired on January 31, 2002. Borrowings were limited to defined percentages of eligible inventory and accounts receivable. Interest on borrowings accrued at the rate of LIBOR plus 1.35% or the prime rate minus 1/2%. As of December 29, 2001, approximately $12.1 million was outstanding under the old bank credit facility, and approximately $1.1 million was utilized to collateralize various letters of credit. The senior notes and the bank credit facility contained restrictive covenants, which include, among other restrictions, a maximum ratio of total funded debt to total capitalization, a minimum fixed charge coverage ratio, a minimum net worth requirement and restrictions on the payment of dividends. Since March 31, 2001, the Company failed to meet the fixed charge coverage ratio covenant which required the Company to maintain a fixed charge coverage ratio of 2:1 for each rolling four quarter period. In addition to the default of the fixed charge coverage ratio covenant, the Company failed to make the scheduled principal payment on its senior notes of $3,333,333 due on November 1, 2001. These covenant violations were waived in connection with the debt restructuring as discussed below. On January 14, 2002, the Company was successful in obtaining restructured financing of its existing debt obligations. As a result of this restructured financing, the Company deferred its November 1, 2001 principal payment and a portion of the scheduled November 1, 2002 principal payment under the senior notes until November 1, 2005. Annual maturities of the senior notes under the restructured financing are $1,500,000 due on November 1, 2002, $3,333,333 due on September 30, 2003, $3,333,333 due on November 1, 2004 and $8,500,000 due on November 1, 2005. These notes bear interest at the fixed rate of 9.00% per annum, with interest paid monthly. The restructured financing also includes an $18 million secured bank credit facility which expires on November 1, 2005. Borrowings are limited to defined percentages of eligible inventory and accounts receivable. Interest on borrowings accrues at the rate of prime plus 2.5%. As of January 14, 2002, approximately $12.1 million was outstanding under the Company's line of credit, and approximately $1.1 million was utilized to collateralize various letters of credit. In addition, the Company had approximately $3.7 million in cash. Under the terms of the restructured financing, both the senior notes and the borrowings on the line of credit are secured by all current and future assets of the Company, including, but not limited to, accounts receivable, inventory, and all real property, plant and equipment. The senior notes and bank credit facility in the restructured financing contain restrictive covenants, which include, among other requirements, the maintenance of minimum shareholders' equity; minimum earnings before interest, taxes, depreciation, and amortization (EBITDA); minimum interest coverage ratio; minimum debt service coverage ratio; capital expenditure restrictions; and prohibition on the payment of dividends. (7) Commitments and Contingencies The Company has various commitments for the purchase of materials, supplies and energy arising in the ordinary course of business. The Company is subject to various claims, lawsuits and administrative proceedings arising in the ordinary course of business with respect to commercial, product liability, environmental and other matters, which seek remedies or damages. Costs to be incurred in connection with environmental matters are accrued when the prospect of incurring costs for testing or remedial action is deemed probable and such amounts can be estimated. The Company maintains reserves which it believes are adequate related to testing, consulting fees and minor remediation. However, new information or developments with respect to known matters or unknown conditions could result in the recording of accruals in the periods in which they become known. The Company believes that any liability that may ultimately be determined with respect to commercial, product liability, environmental or other matters will not have a material effect on its financial condition or results of operations. KENTUCKY ELECTRIC STEEL, INC. AND SUBSIDIARY MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS General. The Company manufactures special bar quality alloy and carbon steel bar flats to precise customer specifications for sale in a variety of niche markets. Its primary markets are manufacturers of leaf- spring suspensions and flat bed truck trailers, cold drawn bar converters and steel service centers. Net Sales. Net sales decreased $1.3 million (7.2%) in the first quarter of fiscal 2002 to $16.0 million, as compared to $17.3 million for the first quarter of fiscal 2001. The decrease in net sales is attributed to a 4.5% decrease in finished goods tons shipped and a 3.8% decrease in the average selling price. The decrease in finished goods tons shipped reflects market conditions throughout the steel industry. The decrease in average selling price is attributed to market price reductions and changes in product mix. Cost of Goods Sold. Cost of goods sold decreased $.1 million (.4%) in the first quarter of fiscal 2002 to $16.9 million, as compared to $17.0 million for the first quarter of fiscal 2001. As a percentage of net sales, cost of goods sold increased from 98.4% for the first quarter of fiscal 2001 to 105.7% for the first quarter of fiscal 2002. The decrease in cost of goods sold for the first quarter of fiscal 2002 from the comparable period in fiscal 2001 is due to the decrease in shipments (as discussed above) offset by an increase in per ton manufacturing costs. The increase in per ton manufacturing costs reflects higher repairs and maintenance costs and other conversion costs offset somewhat by lower raw material costs. The increase in cost of goods sold as a percentage of net sales for the first quarter of fiscal 2002 as compared to the first quarter of fiscal 2001 is due to the decrease in average selling price (as discussed above) and to the increase in per ton manufacturing costs. Gross Profit (Loss). As a result of the above, the first quarter of fiscal 2002 reflected gross profit (loss) of $(.9) million as compared to gross profit of $.3 million for the first quarter of fiscal 2001. As a percentage of net sales, gross profit decreased from 1.6% for the first quarter of fiscal 2001 to (5.7%) for the first quarter of fiscal 2002. Selling and Administrative Expenses. Selling and administrative expenses include salaries and benefits, corporate overhead, insurance, sales commissions and other expenses incurred in the executive, sales and marketing, shipping, personnel, and other administrative departments. Selling and administrative expenses decreased $33,000 for the first quarter of fiscal 2002 as compared to the same period in fiscal 2001. As a percentage of net sales, such expenses increased to 11.4% for the first quarter of fiscal 2002 from 10.7% for the first quarter of fiscal 2001. The increase in selling and administrative expenses as a percentage of net sales is attributed to the decrease in net sales in the first quarter of fiscal 2002. Operating Loss. For the reasons described above, operating loss increased by $1.2 million from an operating loss of $1.6 million in the first quarter of fiscal 2001 to an operating loss of $2.8 million in the first quarter of fiscal 2002. As a percentage of net sales, operating loss increased from (9.2%) in the first quarter of fiscal 2001 to (17.1%) in the first quarter of fiscal 2002. Interest Expense. Interest expense increased by $5,000 for the three months ended December 29, 2001 from $516,000 for the first quarter of fiscal 2001 to $521,000 for the first quarter of fiscal 2002. The slight increase in interest expense is due to an increase in the average amount outstanding on the Company's line of credit offset by a decrease in interest rates. Provision (Credit) for Income Taxes. Due to the loss incurred in fiscal 2001 and the first quarter of fiscal 2002, related debt restructurings, the potential limitation of utilizing net operating losses under Section 382 of the Internal Revenue Code (as discussed below) and management's current belief that the available objective evidence creates sufficient uncertainty regarding the realizability of previously recognized deferred tax assets, the Company recorded a valuation allowance of approximately $1.2 million during the first quarter of fiscal 2002 which fully offsets recognized deferred tax assets. The Financial Accounting Standards Board Statement No. 109 (SFAS 109) "Accounting for Income Taxes", requires that the Company record a valuation allowance when it is "more likely than not that some portion or all of the deferred tax asset will not be realized." The Company will continue to provide a 100% valuation allowance for the deferred tax asset in the future until the Company returns to an appropriate level of profitability. The ultimate realization of a future tax benefit related to net operating loss carryforwards depends on the Company's ability to generate sufficient taxable income in the future. If the Company is able to generate sufficient taxable income in the future, the Company will reduce the valuation allowance through a reduction of income tax expense (and a corresponding increase in shareholders' equity). The realization of a benefit from net operating loss carryforwards which can, and previously did, generate deferred tax assets, may also be limited by Section 382 of the Internal Revenue Code. Section 382 of the Internal Revenue Code contains rules designed to discourage persons from buying and selling the net operating losses of companies. These rules generally operate by focusing on ownership changes among stockholders owning directly or indirectly 5% or more of the common stock of a company or any change in ownership arising from a new issuance of stock by a company. In general, Section 382 rules limit the ability of a company to utilize net operating losses after a change of ownership of more than 50% of its common stock over a three-year period. Purchases of the Company's common stock in amounts greater than specified levels could inadvertently create a limitation on the Company's ability to utilize its net operating losses for tax purposes in the future. Net Loss. As a result of the above, net loss increased by $2.0 million for the three months ended December 29, 2001 from a net loss of $1.2 million for the first quarter of fiscal 2001 to a net loss of $3.2 million for the first quarter of fiscal 2002. Liquidity and Capital Resources. The Company considers its level of cash, availability under its line of credit, and its current ratio and working capital to be its most important measures of short-term liquidity. In terms of long-term liquidity indicators, the Company believes its historical levels of cash generated from operations and required debt repayment to be the most important measures. Cash flows used by operating activities were $4.7 million for the first quarter of fiscal 2002 as compared to $3.0 million for the first quarter of fiscal 2001. First quarter of fiscal 2002 cash flows reflect the net loss of $3.2 million, $.7 million in depreciation and amortization, a decrease in accounts receivable of $1.8 million, an increase in inventories of $.8 million, a reduction of $1.7 million in accounts payable, and a reduction of $1.2 million in accrued liabilities. The decrease in accounts receivable is due to the decrease in shipments for the quarter as well as the decrease in average selling price of finished goods tons shipped for the quarter. The increase in inventories reflects the increase in finished goods inventory offset somewhat by a decrease in raw materials inventory. The decrease in accounts payable reflects the lower operating levels. The decrease in accrued liabilities is attributed to the payment of interest on long-term debt and the annual deposit of profit sharing and 401K matching funds with the trustee. The first quarter of fiscal 2001 cash flows reflect a net loss of $1.2 million, $.7 million in depreciation and amortization, a decrease in accounts receivable of $3.2 million, a reduction of $3.3 million in accounts payable, and a $1.3 million reduction in accrued liabilities. Cash flows used by investing activities were $10,000 for the first quarter of fiscal 2002 as compared to $185,000 for the first quarter of fiscal 2001. The cash flows used by investing activities for the first quarter of fiscal 2002 and fiscal 2001 were used for capital expenditures. Cash flows used by financing activities were $26,000 for the first quarter of fiscal 2002 as compared to $1.4 million for the first quarter of fiscal 2001. The cash flows used by financing activities for the first quarter of fiscal 2002 reflect net repayments of $26,000 on the Company's line of credit. The cash flows used by financing activities for the first quarter of fiscal 2001 reflect repayments on long-term debt of $3.3 million offset by net advances of $2.0 million on the Company's line of credit. Working capital at December 29, 2001 was $11.9 million as compared to $15.9 million at September 29, 2001, and the current ratio was 1.6 to 1.0 as compared to 1.7 to 1.0. The Company's primary ongoing cash requirements are for current capital expenditures and ongoing working capital. Since March 31, 2001, the Company has failed to meet the fixed charge coverage ratio covenant which required the Company to maintain a fixed charge coverage ratio of 2:1 for each rolling four quarter period. In addition to the default of the fixed charge coverage ratio covenant, the Company failed to make a scheduled principal payment on the unsecured senior notes of $3,333,333 due on November 1, 2001. These covenant violations were waived in connection with the debt restructuring as discussed below. On January 14, 2002, the Company was successful in restructuring its existing debt obligations. As a result of this restructured financing, the Company deferred its November 1, 2001 principal payment and a portion of the scheduled November 1, 2002 principal payment under the senior notes until November 1, 2005. Annual maturities of the senior notes under the restructured financing are $1,500,000 due on November 1, 2002, $3,333,333 due on September 30, 2003, $3,333,333 due on November 1, 2004 and $8,500,000 due on November 1, 2005. These notes bear interest at the fixed rate of 9.00% per annum, with interest paid monthly. The restructured financing also includes an $18 million secured bank credit facility which expires on November 1, 2005. Borrowings are limited to defined percentages of eligible inventory and accounts receivable. Interest on borrowings accrue at the rate of prime plus 2.5%. As of February 11, 2002, approximately $9.5 million was outstanding under the Company's line of credit, approximately $1.1 million was utilized to collateralize various letters of credit and $4.7 million was available for additional borrowings. Under the terms of the restructured financing, both the senior notes and the borrowings on the line of credit are secured by all current and future assets of the Company, including but not limited to, accounts receivable, inventory, and all real property, plant and equipment. The senior notes and bank credit facility in the restructured financing contain restrictive covenants, which include, among other requirements, the maintenance of minimum shareholders' equity; minimum earnings before interest, taxes, depreciation, and amortization (EBITDA); minimum interest coverage ratio; minimum debt service coverage ratio; capital expenditure restrictions; and prohibition on the payment of dividends. Though the Company will continue its aggressive working capital management and cost reduction initiatives, continued losses similar to those incurred in fiscal 2001 will severely limit the Company's ability to provide future liquidity from operations and remain in compliance with the new covenants of the restructured financing. There can be no assurances that long-term cash requirements and compliance the new debt covenants will be met if the Company continues to incur significant financial losses for an extended period of time. Outlook Management believes that the sluggish economy will continue during fiscal 2002. As a result, shipping levels, pricing, and margins will likely remain under pressure. The Company believes improvements in the overall economy combined with the Bush Administration's Section 201 initiatives related to imports should have a positive impact on the domestic steel industry and the demand for our products. Qualitative and Quantitative Disclosure About Market Risk The Company is exposed to certain market risks that are inherent in financial instruments arising from transactions that are entered into in the normal course of business. The Company does not enter into derivative financial instrument transactions to manage or reduce market risk or for speculative purposes but is subject to interest rate risk on its fixed interest rate secured senior notes. The bank credit facility has a variable interest rate which reduces the potential exposure of interest rate risk from a cash flow perspective. The fair value of debt with a fixed interest rate generally will increase as interest rates fall given consistency in all other factors. Conversely, the fair value of fixed rate debt will decrease an interest rates rise. The Company is also subject to increases in the cost of energy, supplies and steel scrap due to inflation and market conditions. Forward-Looking Statements The matters discussed or incorporated by reference in this Report on Form 10-Q that are forward-looking statements (as defined in the Private Securities Litigation Reform Act of 1995) involve risks and uncertainities. These risks and uncertainities include, but are not limited to: reliance on the truck and utility vehicle industry; excess industry capacity; product demand and industry pricing; volatility of raw material costs, especially steel scrap; intense foreign and domestic competition; management's estimate of niche market data; the cyclical and capital intensive nature of the industry; and cost of compliance with environmental regulations. These risks and uncertainities could cause actual results of the Company to differ materially from those projected or implied by such forward-looking statements. PART II. - OTHER INFORMATION ITEM 6. Exhibits and Reports on Form 8-K A) Exhibits 3.1 - Certificate of Incorporation of Kentucky Electric Steel, Inc., filed as Exhibit 3.1 to Registrant's Registration Statement on Form S-1 (No. 33-67410), and incorporated by reference herein. 3.2 - By-Laws of Kentucky Electric Steel, Inc., filed as Exhibit 3.2 to Registrant's Registration Statement on Form S-1 (No. 33-67140), and incorporated by reference herein. B) Reports on Form 8-K - None SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. DATED: February 11, 2002 KENTUCKY ELECTRIC STEEL, INC. (Registrant) \s\ William J. Jessie William J. Jessie, Vice President, Secretary, Treasurer, and Principal Financial Officer -----END PRIVACY-ENHANCED MESSAGE-----